High Court implies duty of good faith into distributorship agreement

In a recent decision, the High Court has implied a duty of good faith into a Distribution Agreement: Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB).

In construing the contract to include aspects of such a duty, Mr Justice Leggatt commented that the relevant background against which contracts are made includes not only matters of fact known to the parties but also "shared values and norms of behaviour", such as an expectation of honesty and fidelity to the parties' bargain.  This is a novel approach. The implication of ethical standards into commercial parties' contractual obligations arguably goes substantially against the grain of English case law. Commercial parties may legitimately be concerned by this approach despite the judge's view that this does not represent an illegitimate restriction on freedom of contract and will not generate excessive uncertainty.

The decision is also notable for the judge's comments that the traditional English "hostility" towards a generally applicable duty of good faith in performing contracts is "misplaced" and "swimming against the tide", though he doubted that English law was as yet ready to recognise a requirement of good faith implied by law into all commercial contracts. 

Whilst it seems unlikely that this decision, which was decided very much on its own facts, will herald a significant change in the approach of the courts, it is the first decision to review the general duty of good faith in the performance of contracts in any depth. Caroline Kehoe and Joanne Keillor comment on the decision below.

	Caroline Kehoe Partner +44 20 7466 2007
	Joanne Keillor Senior associate +44 20 7466 2376

Facts                             

The claimant, Yam Seng, entered into a Distribution Agreement with the Defendant, ITC, pursuant to which ITC granted Yam Seng the exclusive rights to distribute certain fragrances bearing the brand name "Manchester United" in specified territories in the Middle East, Asia, Africa and Australasia.  The contract period initially ran from 12 May 2009 until 30 April 2010, but was later extended until 31 December 2011.    

Leggatt J found that, although the contract was made between two companies, the business relationship was essentially one between the two controlling individuals. What began as a "warm relationship" soured and in July 2010 ended acrimoniously with Yam Seng informing ITC that it was terminating the contract on the basis of ITC's alleged breaches, which included late shipment, undercutting prices and providing false information about its willingness or ability to supply products. 

The judge determined that ITC was in breach of certain express terms of the contract. Two of the breaches were not repudiatory, and Yam Seng had in any event affirmed the contract with knowledge of the breaches, so could not subsequently rely on them as a reason to terminate. The judge found that one breach was repudiatory, but also went on to consider whether a duty of good faith was to be implied into the contract. 

A general obligation of good faith?

Leggatt J noted that the general view among commentators appears to be that in English contract law there is no legal principle of good faith of general application. As expressed by Bingham LJ (as he then was) in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] 1 QB 433 at 439: "English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions to demonstrated problems of unfairness". 

Reasons cited for the "traditional English hostility" towards a doctrine of good faith include an underlying ethos of individualism, whereby parties are free to pursue their own self-interest provided they do not breach a term of the contact, and the fear that such a vague and subjective obligation would create too much uncertainty.  The judge noted however that, if English law does refuse to recognise any such general obligation of good faith, it would "appear to be swimming against the tide" as such a concept is recognised by most civil law systems, as well as other common law jurisdictions including the US, Australia, New Zealand and Scotland. References to good faith have already entered English law via EU legislation (for instance, the Unfair Terms in Consumer Contracts Regulations 1999) and a duty of "good faith and fair dealing" is included in the European Commission's proposed Regulation for a Common European Sales Law (see post).

Whilst doubting that "English law has reached the stage…where it is ready to recognise a requirement of good faith as a duty implied by law, even as a default rule, into all commercial contracts" Leggatt J stated that he nevertheless saw no difficulty in "following the established methodology of English law of the implication of terms in fact, in implying any such duty in any ordinary commercial contract based on the presumed intention of the parties".

Good faith as an implied term

Applying Lord Hoffmann's approach from the Privy Council decision in Attorney General for Belize v Belize Telecom Ltd [2009] 1 WLR 1988, the traditional tests for implication of terms could be analysed as part of the exercise of construction of the contract: what would the contract, read as a whole against the relevant background, reasonably (and objectively) be understood to mean?

Importantly, the judge found that the relevant background includes not only matters of fact known to the parties but also shared values and norms of behaviour, including:

1. an expectation of honesty and the observance of other generally accepted standards of commercial dealing, i.e. avoiding conduct which might be described as improper, commercially unacceptable or unconscionable, even if not necessarily dishonest; and
2. fidelity to the parties' bargain, or behaving in accordance with the values and purposes expressed or implicit in the contract. 

The judge commented that these two aspects of good faith are consistent with the way in which express contractual duties of good faith have been interpreted in several recent cases including Berkeley Community Villages Ltd v Pullen [2007] EWHC 1330 (Ch) and CPC Group Ltd v Qatari Diar Real Estate Investment Co [2010] EWHC 1535 (Ch).

Leggatt J drew support from the fact that English law implies a duty of good faith into certain categories of contact, for example contracts of employment and contracts between partners or others whose relationship is categorised as a fiduciary one.  He stated that what he termed "relational contracts", such as some joint venture agreements, franchise agreements and long term distributorship agreements, "may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties' understanding and necessary to give business efficacy to the arrangements".

On all these grounds Leggatt J expressed the view that there is nothing novel or foreign to English law in recognising an implied duty of good faith in the performance of contracts, with the concept  already reflected in several well-established lines of authority.  To the extent that the traditional English "hostility" towards a doctrine of good faith in the performance of contracts still persists, the judge suggested that it is "misplaced".  The judge reasoned that because the content of the duty is heavily dependent on context and established through a process of construction of the contract, and therefore the presumed intention of the parties, its recognition is entirely consistent with the case by case approach favoured by the common law. It is not, in the judge's view, an illegitimate restriction on parties' freedom to pursue their own interests and there is nothing unduly vague or unworkable about the concept. 

Implication of specific terms

Applying this approach, Leggatt J found that two specific terms were to be implied into the Agreement:

1. ITC would not knowingly provide false information on which Yam Seng was likely to rely; and
2. ITC would not authorise a domestic retail price for any product which undercut the duty free retail price specified in the Agreement.  Leggatt J reasoned that whilst he would ordinarily see no justification for implying such a term, because the reasonable commercial expectation would be that ITC was free to sell its products to others on such terms as it chose unless it had expressly agreed otherwise, "contextual features" lead him to conclude that there was such an implied term in this case. These included the fact that the Agreement was "skeletal" and evidently not professionally drafted, but the decisive feature was that the background to the Agreement included an industry assumption that retail prices in domestic markets would be higher than duty free prices; the parties would reasonably have expected the Agreement to reflect this assumption without needing to spell it out.      

ITC was found to be in repudiatory breach of the first term, but not the second. Leggatt J commented "the nature of the dishonesty, on a matter of commercial importance in Yam Seng's dealings with its customers, was in my view such as to strike at the heart of the trust which is vital to any long term commercial relationship, particularly one which is dependent as this relationship was on the mutual trust of two individuals ".     

Comment

As Leggatt J recognised, the general view among commentators is that English law does not recognise a general duty of good faith by parties performing contracts. 

The core of the judge's analysis was the application of the principles of modern contractual construction to the implication of terms, where he derived support from the leading authorities.  Nonetheless, the implication of ethical standards into commercial parties' contractual obligations is a novel approach and arguably goes substantially against the grain of English case law.  This case was decided very much on its specific facts: the judge placed emphasis on the type of contract at issue, although he also commented on the relationship between the controllers of the contracting companies in addition to what he considered to be the longer term nature of the contract.  It may be that, subject to any appeal, the authority can be distinguished on these or other bases in the future. 

The judge's more far-reaching comments about a generally applicable obligation of good faith highlight the difference between the approach under English law and those of a number of other jurisdictions, as well as perhaps the approach of international contracting parties (even though the English courts would not recognise the doctrine).  The concerns about that approach are, as he recognised, well-rehearsed and it may be too big a step for them to yet be disregarded, in particular by commercial parties.  These concerns have been reiterated recently, in the Government's response to the proposal for a Common European Sales Law (a new set of contract law rules for cross-border contracts) to which Leggatt J referred (see post).  The Government concluded that the proposed concept of "good faith and fair dealing" is problematic, on the basis that it is at odds with freedom of contract and commercial practice, risking interference with a business being able to manage their risk with any certainty. 

To the extent that commercial parties have any concerns about the wider implications of this decision as matters stand, one approach they might take is to address the matter expressly in the contract, making clear the terms and scope of any such duty.  However, as Leggatt J acknowledged, it is difficult to conceive that contracting parties might attempt to exclude altogether the core requirement to act honestly.